Submission to HM Treasury Consultation on Future Regulatory Regime for ESG Ratings Providers

Background

In recent years there has been a boom in the number of companies offering services to evaluate and rate companies’ performance on environmental, social and governance (ESG) factors. However, without regulation this market has become increasingly confusing and almost counterproductive, as we have demonstrated in past publications.

It is therefore welcomed that relevant UK authorities are considering a future regulatory regime to address this situation. On 30 June 2023, IEEFA submitted its response to the HM Treasury Consultation on Future Regulatory Regime for ESG Ratings Providers. Further to our publications, IEEFA’s submission provides our recommendations to the UK authorities on how regulatory intervention could address shortcomings in the ESG ratings industry.

IEEFA will continue to closely monitor related regulatory developments, including but not limited to: The industry working group’s draft voluntary code of conduct, the EU ESG ratings regulation proposed by the European Commission and those proposed or established in other major financial markets, including Japan and Singapore.

Summary

IEEFA recommends that the FCA be clearer in determining the scope of ESG ratings, to avoid confusion and loopholes in the market.

In IEEFA’s view, the proposed regime has not yet addressed the aspects of ESG ratings’ methodologies, governance and processes. Hence, IEEFA urges the Treasury to initiate the respective regulatory measures on those fronts as they are important to safeguard the creditability and usability of ESG ratings.

Recommendations

In determining the scope, IEEFA recommends that the FCA should:

• Seek to define what an ESG rating should reflect to enhance comparability, albeit there may be a diverse set of ESG rating-like products.
• Provide clear scope thresholds and description, including a definition of ‘minimally processed data’, to prevent products that are branded in other ways but contain ESG rating-like assessments or opinions from being left ‘out-of-scope’.
• Phase in a mandatory code of conduct for ESG data providers, given the reliance of ESG ratings on ESG data and the ongoing evolution and refinement of certain elements of ESG data (such as the calculation of Scope 3 emissions in different sectors).
• Revisit the exclusion of second-party opinions (SPO) and address the potentially higher conflict of interest concerns by ‘issuer-pays’ business models usually seen in SPO services.
• Set a minimum standard required for all rating providers, including smaller players, to level the playing field.

Furthermore, IEEFA sets out our recommendations to the FCA regarding methodologies, governance and processes based on our reports. For further information and detail, download the complete submission.